Opinion

The Truth About the Aging Brain

Fredrik is a managing director of State Street Global Advisors and the head of Global Defined Contribution.

Aging is not only skin deep. It has a profound effect on our brains. While Americans spent around $13.5 billion on aesthetic plastic surgery in 2015 alone to minimize the appearance of aging, we invest little time and, frankly, little money in preparing ourselves financially for a dignified aging process.

Researchers are developing a growing understanding of the ways age affects financial decision-making and our capacity to plan for the future, and advisors can use these insights to help clients build better retirements by: Designing plans that account for the impact that aging will have on participants’ decision-making; Identifying saving, investment and communications strategies targeted to specific age groups; Helping middle-aged clients prepare to meet their needs later in life — not just by allocating assets appropriately but by planning for the possibility of cognitive decline.

Aging can be scary. The antidote to fear is knowledge, so we reached out to David Laibson, a Harvard University behavioral economist who has helped spotlight some of the ways aging affects financial decision-making. Laibson identifies two kinds of intelligence that evolve over a person’s lifetime. Fluid intelligence – the ability to learn and adapt – declines rapidly over time. Whereas Crystallized intelligence – wisdom learned from experience – increases as people age.

Overall cognitive performance draws on both fluid and crystallized intelligence. Laibson’s research finds that it peaks when people are in their 50s.

Changes in intelligence and cognitive performance have a profound impact on financial decision-making. One of Laibson’s inquiries is especially illuminating. He explored the interest rates people paid for loans at various ages (controlling for such factors as credit scores). He found that people in their 50s, who are at the peak of their cognitive abilities, typically pay the lowest interest rates, while people in their 20s and those in their elder years pay the highest rates.

It’s surely no coincidence that people at the peak of their cognitive abilities receive the lowest rates.

Presumably, middle-aged people make better decisions about loans than younger or older people, possibly because they have more accumulated wisdom (greater crystallized intelligence) than younger borrowers and nimbler brains (greater fluid intelligence) than older borrowers. It seems reasonable to expect a similar dynamic with respect to other financial decisions, such as those governing spending, investing and generating income.

These findings may influence the ways advisors help employers manage their retirement plans.

You may be able to perform an analysis of a plan population’s demographics and retirement preparedness, giving the client insight into its participants’ vulnerabilities to age-related factors. For example, if a plan’s population is relatively young, you may want to help the client consider communications strategies that can help younger people overcome their lack of experience to make good decisions. Such strategies might include helping employees understand the importance of compounding and saving early, and the amount of investment risk they can take on at a young age.

Laibson’s research also makes it clear that people should not wait until after they retire to make critical decisions about complex topics such as generating a stream of lifetime income from savings. For plans with a relatively old population, consider how a decline in participants’ cognitive performance could increase risks related to investing and drawdown.

You may want to encourage employer clients to protect against such risks by: Ensuring plan features, communications and drawdown strategies are accompanied by appropriate guidance; Helping employees understand the impact aging can have on decision-making; Using investment solutions and plan design features that steer participants to make major decisions about their retirement finances in middle age.

Aging also heightens the likelihood of cognitive impairment. Laibson notes that cognitive decline begins to accelerate in the 60s, and about half of people in their 80s experience it in some form. Some develop full-blown dementia; yet for financial decision-making the larger problem is the possibility that millions of seniors may make poor financial choices as a result of dementia that is mild and possibly undiagnosed.

Although roughly half of people won’t experience that scenario, it could prove disastrous for those who do, intensifying the urgency for people to make key financial decisions closer to the peak of cognitive abilities.

You can help clients begin to tackle this problem by encouraging retirement plan structures and solutions that address critical financial matters when participants are in their 50s and 60s.

Even participants in their mid to late 40s are ready to begin having realistic discussions about retirement — it is only about 20 years away, and they have watched their parents cope with aging-related challenges.You might work with plan sponsor clients to consider some form of in-plan annuitization, so it’s easy for people to prepare for lifetime income while they are active plan participants.

For individual clients, holding a clear discussion of aging-related risks well in advance can help convey the need to plan, and can encourage faith in you as a skilled and trustworthy professional.

It is particularly valuable to discuss cognitive decline before it occurs, when the issue may become an emotional trigger-point for the client. The advisory industry has room for growth in this area. When we surveyed investors (in our 2015 Multi-generational Wealth Management Toluna Omnibus survey) only 17% said they had planned for cognitive decline with a financial advisor.

Figuring out how to turn their savings into income is one of the most important and complicated decisions people face as they move from middle age to elder-hood.

Consider starting the retirement income conversation relatively early and look to put an income plan in place well before clients reach retirement. Part of the plan might involve using assets from a rollover to purchase a fixed annuity with a cost of living adjustment — perhaps one that starts payments late in life, to provide cost-effective insurance against longevity.

Everyone has to navigate the challenges of aging. We believe that all of us in the retirement community need to tackle its impact head-on, or we risk creating a future in which the repercussions are much scarier than wrinkles. Please join us as we work to help people live with dignity in retirement.

This opinion piece was coauthored by Greg Porteous, a managing director of State Street Global Advisors and head of Defined Contribution Intermediary Strategy within the firm’s Institutional Consulting Group.